Cherry Hill Mortgage Investment Corp (CHMI) 2022 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Cherry Hill Mortgage Investment Corp Third Quarter 2022 Earnings Conference Call. (Operator Instructions). I would now like to hand the conference over to your speaker for today, Garrett Edson. You may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Third Quarter 2022 Conference Call. In addition to this call, we have filed a press release that was distributed earlier this afternoon and posted to the Investor Relations section of our website at www.chmireit.com.

On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to interest income, financial guidance, IRRs, future expected cash flows as well as prepayment and recapture rates, delinquencies and non-GAAP financial measures such as earnings available for distribution or EID and comprehensive income. Forward-looking statements represent management's current estimates, and Cherry Hill assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions contained in the financial presentations available on the company's website.

Today's conference call is hosted by Jay Lown, President and CEO; Julian Evans, the Chief Investment Officer; and Michael Hutchby, the Chief Financial Officer. Now I will turn the call over to Jay.

Thanks, Garrett, and welcome to our third quarter earnings call.

Central Bank policy and macroeconomic pressures persisted in the third quarter, which drove volatility higher and certainly impacted most mortgage assets. persistently high inflation and a well-supported employment market led the Fed to enact to 75 basis point rate hikes in July and September and provided the Fed to cover to again raise rates earlier today. Fed has remained steadfast in telegraphing its mission to lower inflation to its target level and markets have reacted significantly to any rhetoric related to the path and pace of future tightening in this cycle. This has helped fuel expectations for short-term rates to exceed the levels policymakers have previously outlined.

Additionally, the U.S. Treasury to 10s curve inverted 51 basis points over the quarter, moving from plus 6 basis points at 630 to minus 45 basis points at the end of September, signaling the potential for a forthcoming recession. While the U.S. 10-year treasury finished the quarter at 3.8%, 78 basis points above its closing level at June 30, it surpassed 4.25% at one point in October. The increase in rates and the shape of the yield curve were relevant to the performance of RMBS assets in our sector, and much has been discussed about how the rise in treasury rates and increased volatility has impacted mortgage spread widening this year and its impact to REIT book values. While it is our view that Agency MBS looks attractive at these levels, the sector has continued to drift wider in October as others have highlighted. Despite this, we do believe that we are approaching MBS valuations that are attractive and expect to capitalize on that over time.

For now, we have positioned our portfolio for additional rate hikes and further mortgage spread widening as investors look to assess where the Fed will signal a slowdown in this tightening cycle. During the quarter, we worked to effectively minimize the embedded macro risks and focus on what we could control. We selectively deployed capital as we saw opportunities emerge while maintaining a leverage ratio that has room to increase. We were proactive in terms of our hedging strategy and coupon selection, which began at the end of the prior quarter, rotating out of lower coupon MBS into higher coupon MBS. The end result was a solid performance in a very difficult environment. Julian will provide more details on our efforts there shortly.

For the third quarter, we generated GAAP net income applicable to common stockholders of $38.3 million or $1.90 per diluted share, and we generated earnings available for distribution or EAD, a non-GAAP financial measure of $5.1 million or $0.26 per share. This was just below our quarterly common dividend level of $0.27 per share. Our primary focus this quarter was to protect book value, given our view on MBS spread widening. As we've noted before, EAD is only one of several factors considered in setting our dividend policy, and we and our board continue to monitor our earnings capabilities to ensure our dividend is at an appropriate level.

Book value per common share finished at $6.05 as of September 30, and a material amount of this is simply a function of preferred stock still making up a significant portion of our overall equity profile. On an NAV basis, which does not account for the difference in common or preferred equity, our strategy of pairing RMBS with agency MSRs continues to effectively minimize risk and moderate the impact of spread widening on Agency RMBS. NAV in the quarter was off approximately 5.1% quarter-over-quarter before taking into account any common stock issuances pursuant to our ATM program. We remain committed to stabilizing and growing our NAV and book value and using all of our tools to navigate through the current environment.

During the third quarter, we acquired approximately $1.2 billion UPB and Fannie and Freddie MSRs by a flow and bulk purchases. Prepayment speeds on our MSR portfolio have declined materially, and as such, the pace of reinvestment to maintain the allocation of capital to the asset class has slowed. Our strategy of pairing MSRs with Agency RMBS, along with proactive portfolio management and hedging benefited shareholders this quarter given the composition of the overall portfolio. Our recapture efforts remain solid with a 7% recapture rate on our MSRs in the quarter despite the ongoing rapid rise in mortgage rates. We would expect the capture rates should further decline at these higher interest rate levels, though, prepayment speeds net of recapture should continue to remain low.

At the end of the quarter, financial leverage increased modestly to 4.2x as we saw opportunities late in the quarter to deploy capital opportunistically. Given the current heightened market volatility, we believe we remain prudently levered and we're cognizant not to be too aggressive in increasing our leverage. We ended the quarter with $43 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

Looking ahead, we will continue to selectively deploy capital where we see clear risk-adjusted opportunities as we closely monitor central bank monetary policy actions and their impact on global markets and MBS spreads. We expect to maintain an elevated hedge ratio as we remain positioned for a bias towards further Fed tightening of monetary policy and a higher rate environment for the foreseeable future as inflation persists, and we expect economic headwinds to carry into 2023. We will also continue to actively adjust our investment portfolio to protect the business and remain mindful of our liquidity and leverage profile in this dynamic environment to preserve book value.

With that, I'll turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the third quarter.

hank you, Jay. The third quarter was not a good quarter for mortgages, as Jay stressed. Higher volatility, wide bid-ask spreads and limited liquidity described the sector best. Throughout the quarter, the mortgage basis underperformed significantly. According to Bloomberg, the mortgage index underperformed hedges by 169 basis points for the quarter, a performance number that was worse than all of 2020, the year of the pandemic. Said differently, nominal spreads touched the pandemic wise of 2020.

Since the start of 2022, the Fed has raised the Fed's funds rate significantly, inclusive of today's rate increase, leading to a significant weigh on the mortgage sector. Given current inflation and unemployment levels, the market expectations are for the Fed to raise the Fed fund rate to a terminal level of $4.50, $4.75. One of the fastest rate path the Fed is undertaken to normalize the Fed funds rate in its history. We expect the Fed to achieve its goal of reducing inflation, and as a result, we expect volatility to remain elevated, weighing on the mortgage sector despite the vastly improved valuations.

At quarter end, our MSR portfolio had a UPB of $21.4 billion and a market value of approximately $279 million. During the quarter, we purchased approximately $1.2 billion UPB of new MSRs through our bulk and flow programs. At the end of the third quarter, the MSR and related assets represented approximately 38% of our equity capital and approximately 27% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio also accounted for approximately 49% of our equity. As a percentage of investable assets, the RMBS portfolio represented approximately 73%, excluding cash at quarter end. During the quarter, we continued to experience CPR improvements in both our MSR and RMBS portfolios. Our MSR portfolio's net CPR averaged approximately 7% for the third quarter, down from approximately 10% net CPR in the previous quarter. The decline, mainly driven by the continued rapid rise in interest rates, and the change in mortgage production coupons, which drove slower prepayment fees in the quarter. The portfolio's recapture rate was lower at 7% versus 12% in the second quarter, which was expected as interest and mortgage rates rose making the incentive to refinance less. We continue to expect a lower recapture rate, but stable or improved net CPRs given the elevated levels of interest and mortgage rates. The RMBS portfolio's prepayment speeds exhibited similar themes. The portfolio's weighted average 3-month CPR reduced to approximately 4.7% for the third quarter compared to approximately 7% in the second quarter.

As of today, the vast majority of the mortgage universe is out of the money in terms of refinancing. We expect prepayments to remain at low levels as long as interest rates stay at these levels or move higher. As of September 30, the RMBS portfolio inclusive of TBA, stood at approximately $759 million compared to $831 million at previous quarter end. Quarter-over-quarter, the spec full portion of the portfolio grew as we attempted to take advantage of higher interest rates and lower price premiums by putting new cash to work as well as converting dollar rolls into spec pools as the dollar rolls weakened. The total RMBS portfolio number is lower as we hedged a portion of the portfolio with TBAs. We also continue to proactively change the portfolio's composition, moving into higher coupons and reducing spread duration for the portfolio.

At the end of the third quarter, the 30-year securities position represented 96% of the RMBS portfolio, up from 93% at the end of the second quarter. Shorter duration securities made up 4% of the portfolio at quarter end. For the third quarter, we posted a 3 spot 4.9 RMBS net interest spread versus a 6% net interest spread reported for the second quarter, a modest increase. The spread was relatively stable despite increased repo costs. The higher finance costs were offset by resetting LIBOR expenses on our swap portfolio as well as new asset purchases at the higher yield levels and lower dollar prices. At the quarter end, the portfolio's financial leverage stood at approximately 4.2x at the aggregate level and the portfolio was managed with a small negative duration gap.

Looking forward, especially in the fourth quarter, we remain guarded as we expect the investment market to remain volatile for the foreseeable future until there's greater clarity as to the Fed's reaction to inflation and unemployment.

I will now turn the call over to Mike for the third quarter financial discussion.

Thank you, Julian. Our GAAP net income applicable to common stockholders for the third quarter was $38.3 million or $1.90 per weighted average diluted share outstanding during the quarter. While comprehensive loss, attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS, was $7.3 million or $0.36 per weighted average diluted share. Our earnings available for distribution attributable to common stockholders were $5.1 million or $0.26 per share. Our book value per common share as of September 30 was $6.05 compared to the book value of $6.73 as of June 30.

We use a variety of derivative instruments to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings. At the end of the third quarter, we held interest rate swaps, TBAs, treasury futures and options on treasury futures, all of which had a combined notional amount of $1 billion. You can see more details with respect to our hedging strategy and our 10-Q as well as in our third quarter presentation. For GAAP purposes, we have not elected to apply hedge accounting for our interest rate derivatives. And as a result, we recorded the change in estimated fair value as a component of the net gain or loss on interest rate derivatives.

Operating expenses were $3.1 million for the quarter. On September 15, our Board of Directors declared a dividend of $0.27 per common share for the third quarter of 2022, which was paid in cash on October 25, 2022. We also declared a dividend of $0.51.25 per share on our 8.2% Series A cumulative redeemable preferred stock and a dividend of $0.51.5625 on our 8.25% Series B fixed to floating rate cumulative redeemable preferred stock, both of which were paid on October 17, 2022.

At this time, we will open up the call for questions. Operator?

Thank you. (Operator Instructions).

Our first question comes from the line of Henry Coffey with Wedbush.

Two items. On the RMBS portfolio it looks like you've been able to hold funding costs fairly low, and as rates rise, are we going to be able to continue to hold spreads at about where they are now? Or should there be some more downward pressure?

Henry, it's Julian. Look, I think we all know that the Fed is going to continue to raise rates. And we do expect that our repo cost to continue to rise. That is being offset by our swap hedges, whether it's 3-month LIBOR resetting or the SOFR resetting, we've been able so far to fortunately be able to keep our expenses at the levels that they are. So as long as the Fed continues to raise Fed funds, we would expect 3-month LIBOR as well as SOFR to go up. We do have a hedge ratio currently in the portfolio, about 119%. So we are over-hedged from that perspective.

So in a rising rate environment, you should be able to hold spreads about where they are?

We're expecting that. I mean on the asset side, we have changed around the portfolio. Even today, since the end of the third quarter, we continue to manage the portfolio, continue to adjust on the asset side as well, not just on the liability side, I would say.

Is the mindset to expand the RMBS portfolio or just kind of turn it over as trading opportunities present themselves or assets mature?

Henry, it's Jay. I would say that the MSR portfolio is not all that liquid. So there isn't a ton of room for us to substantially add to that.

No, I meant on the RMBS book.

Yes. No. So what I'm saying is from a capital allocation perspective, equity, I would say things shouldn't change much. But as I alluded to on the call, we think that we're approaching wides for spreads. And once we feel as though we're getting closer to those wides, we'll be more inclined to increase the leverage in that portfolio. So a percentage of assets wise, I think you could see RMBS going higher as a percentage of equity, not significantly, I would say.

In the line of business stuff on Slide 20, there was another expense in the servicing business of 12.1%. What was that all about?

So the income statement here being broken down across the different segments, takes the entire portfolio and divvies it up. And so the servicing and related asset segment includes not just the MSRs themselves but also related assets and hedges. And so you might see as the MSR values increase, you would see that their MSR hedges, those swaps, those values would be impacted, and you'd see that show up here.

Our next question comes from the line of Mikhail Goberman with JMP Securities.

Just a couple of quick questions. Just wanted to gauge your appetite on further stock issuance. I noticed you guys went from about 19.6 million shares to just under $21 million quarter-over-quarter and putting that capital to work. And also sort of commensurate with that, wanted to gauge your appetite for how high up could leverage you go? I mean we're talking about maybe getting up towards a 5 handle at 4.2 now. And finally, if I may add a third, just a quick update on book value thus far in the fourth quarter.

Sure. Related to the leverage, I think that's a fairly fluid conversation. We haven't really assigned a number to that. I think we're a lot more focused on making sure that we have a pretty good view collectively on the right time to get more involved in the RMBS space. And I think so far, we've made the right moves with respect to kind of limiting the additional leverage we've taken on that. The first part of your question was...

It was to do with using the ATM in the quarter.

So the capital that we raised in the third quarter was accretive to book, and I believe the total that was raised definitely added to our book value for the quarter. So we felt good about that. We have tapped the ATM primarily this year, actually exclusively this year at most. And I would expect us to continue to tap the ATM at the appropriate time, given where the stock trades relative to book relative to the amount. I don't know, but I would tell you that, again, as we get closer to what I think we would consider the wides for the RMBS and at a point where we think the Fed sort of tap out in terms of the terminal rate per rates, I think there's a really good opportunity to invest in our space in the agency side for agency REITs who rely on the basis for accretive book value moves. And so I would love to be able to be in a position to take advantage of that on a larger scale at the appropriate time. The extent to which we'll be able to do that, again, it depends on things not really inside our control related to how the stock trades. But we do think that there is an opportunity coming relative to being able to add assets in that asset class at decent levels. As for the current book value, as of the end of October, I'll let Mike give you that.

Yes. So it's obviously still very early as it's just the very beginning in November, but from what we have put together, we see October 31 book value per share down about 1% from where it was at September 30. And that is, of course, before any fourth quarter dividend accrual as the board has not yet met to review and approve a dividend for the quarter.

I'm showing no further questions in the queue. I would now like to turn the call back over to Jay Lown for closing remarks.

Great. Thank you. Thank you, everybody, for joining us for our third quarter conference call. And we do look forward to updating you sometime in February and March of next year to apprise you of our fourth quarter results for 2022. Have a great day. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.